In one sentenceThe extent to which a change in sales is magnified in operating profit because of fixed costs; it is measured by dividing the contribution margin by operating profit.
Simply put
A business with high fixed costs earns a lot when sales rise and loses a lot when they fall. This leverage works in both directions.
A degree of leverage of 2.5 means a 10% rise in sales raises operating profit by 25%, and a 10% fall lowers it by 25%.
Worked example
A factory has a contribution margin of 100,000 SAR and fixed costs of 60,000 SAR.
Operating profit = 100,000 − 60,00040,000 SAR
Degree of leverage = 100,000 ÷ 40,0002.5
If sales rise 10%: contribution margin 110,000 − 60,000Profit 50,000 SAR
Profit increase when sales rise 10% = 10,000 ÷ 40,00025%
Formula: Contribution margin ÷ Operating profit
Don't confuse it with
Financial leverageFinancial leverage comes from borrowing and financing costs, while operating leverage comes from fixed operating costs.